Asset swap

Since it is a swap of assets, the procedure takes place on the active side of the balance sheet and has no impact on the latter in regard to volume.

A company often utilizes this method when in need for money to invest (internal financing) or to pay off debts.

An example of this is where an institution swaps the cash flows on a U.S. Government Bond for LIBOR minus a spread (say 20 basis points).

Such swaps usually have stub periods in order to bring the chronology of the cash flows into line with that of the underlying bond.

For the purpose of the following, we assume we have constructed a market curve of Libor discount factors where z(t) is the price today of $1 to be paid at time t. From the perspective of the asset swap seller, they sell the bond for par plus accrued interest ("dirty price").

Both parties to the swap are assumed to be AA bank credit quality and so these cash flows are priced off the Libor curve.

This feature prevents the calculated asset swap spread from jumping as we move forward in time through coupon dates.